pension essay questions and answers
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7/30/2019 Pension Essay Questions and Answers
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Pension Essay Questions and answers:
(ignore the question #s)
Questions asked most frequently in past exams:
1)Theoretically justify why actuarial g and l seldom create large adjustments to pension expense. How
would you advise the funding manager of a defined benefit pension plan to tret these gains in his
decision on how much to fund to a plan?
We expect them to even out in the long run and if we are going radical in one direction they
should be smoothed out of working years to match benefits with epenses. They however affect
funding decision immmediatly as loss can cause cash shorteges and vice versa. So funding
manager must realize that long term trends may reverse but must react to shortages quicker
than accountants.
2) explain why a defined benefit pension plan may have a greater positive effect on loyalty of employees
than a defined contribution plan. Indicate the administrative and tax differences that may affect a
companys decision as to which to adopt in a business?
4) what is the primary theoretical issue in determining pension expense? Theoretically justify and
indicate how the treatment of actuarial gains and losses reflects that principle?
It is matching pension expense to benefits received since benefits coming from employees
(loyalty, focus contentment) are smooth over time expenses should be smoothed over time.
Actuarial gains and losses are expected to counteract one another over time so we do not over
react in three ways:1) wait till next year to consider gand and loss 2) only gain and loss outside
acceptable range or corridor 3) amortize the excess over time
6) Explain whether actual or expected return on assets are used to determine pension expenses and
why this is so. Which # is used to determine the liability requirement and why is this so?
Expected return is used to help create a smoothing pattern to pension expense which reflects
the smooth benefit pattern received from employees and satisfies the matching principle. In
Liability requirements the fair value of the plan assets is used to determine liability and the plan
asset values reflect actual return on assets. This is because only actual assets could be sold to
pay off pension benefits therefore they should be used t o measure remaining liabilities to be
presented on the balance sheet, the reality is needed on balance sheet.
7) Explain how a large unfunded amendment to a pension plan can affect the liabilities reported under a
pension plan if it is announced on 12/31 of a year. Briefly explain why this unfunded amendment
doesnt affect the pension expense of that year in the same way.
An unfunded amendement will increase the pbo immediately and therefore increase liabilities
on the 12/31 balance sheet. Expenses will not be affected until the following year because
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benefits of the amendment are not obtained until then and matching demands that expense
occur when benefits do.
10) A) actuarial gains and losses get unique treatment on financial statements. Justify the treatment
theoretically and how might this deceive a reader of an income statement. B) How might the balance
sheet help the reader understand the situation surrounding large actuarial losses? How about gains? C)Explain how the footnotes of the financial statements might help the reader understand the situation
regarding large actuarial losses? How about gains?
A) the unique treatment is to spread them out or ignore them unless substantial because they
will tend to cancel out in the long run, employee benefits do not reflect the actuarial gains and
losses, matching the cost to benefit crucial
B) Because the actuarial gain and loss imact the ABO and the ABO is a key factor in determining
B/s results if they are necessary -> large actuarial losses may be required to be shown on B/S.
However since we do not let ABO B/S due to gains appear on B/S gains are not shown on B/S.
C) However since the comparison to PBO is made in footnote and gains and losses impact
footnote disclosure they will both be apparent to the reader.
Questions asked less frequently:
3) Indicate and theoretically justify the 3 different viewpoints of the obligations a company has to its
employees who are eligible for a defined benefit pension plan. Indicate what elements drive each
viewpoint and where on the financial statement the viewpoint will appear? (was on prior to 2007 test)
Viewpoint 1) balance of prepaid/ accrued pension cost account. This is result of matching cost to
benefit periods and simply is based on the fact that if you paid more than exp then asset if paid
less than exp then liability.
Viewpoint 2) ABO- FV plan assets at the B/S date this is based on conservatism principle
meaning that if the plan ends tomorrow and we are short funds to pay everyone off we must tell
the reader of the shortage.
Viewpoint 3) PBO- FV PA or funding status this is even more conservative but it show whatfunding goals are for the company based on actuary prediction and represent how close we are
to goal and shows any shortage.
5) explain what alternative methods to straight line amortization exist for amortizing prior service cost in
a defined benefit pension plan and theoretically justify its use. What does the fasb recommend?
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There is a method that is similar to sum of years digits amortization that is recommended by the
fasb it assigns more expense to the earlier periods and assigns cost to all periods that employees
who are awarded prior service credit. This is best because the # of employees that remain with
the company diminishes over time and therefore benefits diminish. The matching principle
demands that costs are ecpensed in accordance with benefits.
8) (question not listed only answer) winter 2012 exam
pension expense doesnt equal contribution because in gaap we must match the expense to the
benefits received since the benefits from employees is smooth over time we must make an
effort to spread these costs out and funding is not always spread out equally each year. It
depends on the availability of cash.
9) How do you check the OCI account is correct?
You check OCI by making sure it equals unrecognized prior service costs which equals
components 4,5,6 and 7 that have not been expensed or recognized.
11)A) Explain the pros and cons of a defined benefit versus a defined contribution pension plan from the
companies viewpoint B) from the employees viewpoint C) suppose the average annual rate of return on
assets is 30%. Explain how this would affect your answer to item a)
A) The companies viewpoint on defined Contribution pros : Know exactlyu what cost will be.
Con has less long term impact on employee. Defined benefit pros: keeps employee focusing on
today, could cost very little if dies early Cons: cost could be overly high if individual lives long or
salaries increase, hard to account for.
B) Employee Pros: assured of same standard of living during retirement Cons: If market triplesyou dont own funds until retire
C) IF huge return company reaps benefit on defined benefit plan thus defined benefit plan may
have been better (less costly) if this huge return continues
12) explain how the accounting treatment of other post retirement benefits satisfies the matching
principle. Give several expamples.
The factors that determine other post retirement expenses are smoothed out to reflect smooth
benefits thus satisfying matching principle. Spread out actuarial gain and losses. Expected return
rather than actual return for # 3, spread out prior service costs, service cost only this years work
13) Theoretically justify the accountants treatment of a large actuarial loss incurred early in a pension
plans life. What basic principle of accounting may be broken by this treatment?
Little to no expense this period, will offset in the future, benefits are smooth from employees,
matching demands expenses be smoothed as well. It violates conservatism and full disclosure. It
is unusual to not recognize losses as soon as possible.
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14) (question missing on test) fall 2007
There is an Other comprehensive Income Account which is located in the stockholders equity
section of the balance sheet and the current years adjustment shows up in the other
comprehensive income statement. Its balance should be equal to unrecognized prior service
cost that still exist in the plan ( components 4, 5 and 6) which have not been recognized to date.
15) Explain why accountants attempt to smooth out pension expense and why this may cause
the need for a second journal entry related to defined benefit pension plans. Give 3 examples of
how accountants execute the smoothing effect and where in a financial statement package (
besides I/S and B/S a reader can learn more about this smoothing effect and how it relates to
the true funding needs of the plan.
The benefits coming from a pension plan are relatively smooth and to match costs with
benefits we must smooth or spread expenses according to benefits. Because we dont
always receive those benefits as expected liability. May be owed sooner or more than
predicted. A second calculation surrounding potential additional liability problems is
necessary to satisfy B/S needs for conservatism 3 examples of smoothing are: 1)
discount rate rarely changes 2) use expected rate of return 3) amortize PSC using S/L 4)
amortize actuarial G/L using S/L 5) only amortize actuarial G/L in excess of corridor 6)
take S/C at 1/30 of total costs
16) Explain what the funding status of a companys pension plan is useful for and indicate where it may
be found in a financial statement package. Does this amount impact the liability balance of the
company? Why or why not?
Funding status is the relationship between the PBO, the long term goal set by the actuary forassets necessary to pay for the plan and the actual asset set aside in the plan. It is helpful for the
treasurer or finance people in a company to help them make funding decisions to the plan. It is
found in the footnotes not on the B/S or I/S.
Accountants do not consider it part of their liabilities because this amount includes future salary
levels of employer which have notbeen obtained they are technically not a liability at this date
since the employee has not attained that salary level.